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Your future … seriously

The science fiction author Isaac Asimov, inspired by his visit to the New York World’s Fair back in 1964, wrote down some predictions of life 50 years hence. Fifty years from 1964 brings us to today, and the New York Times recently re-published the piece in honor of the occasion.

What did Mr. Asimov foresee that came true? To me, his most impressive predictions were flat-screen televisions and Skype on iPads. However, anyone projecting life 50 years hence can be expected to whiff on a few calls, and Mr. Asimov didn’t disappoint. We do not have colonies on the moon and Mars, which means we’re spared the communication problems Mr. Asimov predicted we’d have.

How long?

All fun aside, where will you be 50 years from now? Alive, to begin with. Life expectancy is rising dramatically thanks to the advances in medical science, health consciousness and improvements in diet and exercise. In the last century or so, we’ve seen our life expectancy increase by more than 20 years. Although the actual numbers are fuzzy, differing, as they do, by country, gender and whether or not you had a world war or flu pandemic in your life, the trend is inescapable. It’s easy to dismiss a 100-year trend as not applying to you, but think again. Odds are you are going to live another 50 years, which means you can add another ten years to what you expected as your lifespan.

It may sound like a nice thing, being able to live longer, but it’s not a cheap thing. Laws and customs don’t always change as fast as your life expectancy, and so you have rules like retirement beginning at 60. When you add people who are able to retire earlier, it’s not too much of a reach to find more and more people living longer in retirement than in their earning years.

In case you thought that when you’re 60, or thereabouts, you’ll just keep right on working, think twice. Not too many employers hire people over 60. They typically like to think every new hire will spend ten years or more with the company, and the odds of a 30-year old staying (and being productive) just seem better to them than the gray-haired applicant.

If you’re smart, you will invest with a view to have the freedom to spend the rest of your life in a financial position where you don’t need to work.

How much?

Let’s imagine you are the manager for the pension fund that’s committed to pay me $60,000 a year till I die. Life insurance companies and pension funds approach the problem with what they call an endowment — an amount of money which will yield enough cash every year to pay the $60,000. That amount comes from a combination of interest or dividends and a gradual depletion of the principal.

So how much money will you need as an endowment to pay me my $60,000 a year? Mathematically, you calculate this the same way you calculate the amortization of your home loan: Every payment has an interest component and a principal component, and the pot is empty at the end of the term.

Let’s say you think I’m going to live another 20 years, and you can get a yield of 4 percent per year from safe bonds. For that scenario, you’d need an endowment of about $825,000.

Now, let’s say interest rates drop to 3 percent because the Fed decides to expand the money supply. That drop will require an increase in the endowment to about $900,000.

As pointed out above, our life expectancy is increasing, so let’s say I live another 30 years instead of the 20 you were counting on. For that, the endowment would need to be approximately $1.2 million — a significant jump.

You see the problem: At the time of my retirement you had to make a decision on how much to set aside. Two changing circumstances caused the endowment to be underfunded by 44 percent. And both those changes are happening before our very eyes, so this is not purely hypothetical.

By the way, this is exactly how Social Security has come to be underfunded: Since the time they made their funding determinations, interest rates have dropped and life expectancy has increased. It turns out that making funding decisions is similar to being a Denver weather anchor — you know you’re going to be wrong most of the time, but you have to do the job anyway.

Of course, interest rates could go up, which would improve things a lot. Should interest rates climb to 6 percent, the amount needed drops again to just over $830,000, even with the longer life expectancy — pretty close to the original endowment.

You can see the problem. Making determinations about the future is tricky at best. The people who do it have to choose a set of assumptions and act accordingly. Everyone knows they’ll be wrong, but nobody knows by how much. And everyone hopes that something good (like rising interest rates) will come along to bail them out.

This fuzziness is giving rise to another problem, however. Those who make these decisions answer either to politicians or CEOs, and that spells trouble. Let’s say a CEO is a little short on earnings for a particular quarter. It’s easy for him to step over to the company’s pension fund manager and say, “Hey, assume an extra 0.5 percent on the yield.” The pension fund manager has to follow orders or lose his job. The result is the company’s pension fund suddenly is over-funded. The company takes back the over-funding and — voila! — the CEO met his earnings target and collects his nice, fat bonus.

The same happens at governmental pension funds. The first crack in the dyke came in 2006 when the Northern Mariana Islands, a U.S. commonwealth consisting of three major islands in the Western Pacific, declared that it didn’t have enough funds to cover the commitments to future retirees and attempted to declare Chapter 11 bankruptcy. The Detroit situation last year is better known because it’s bigger and closer to home. The problem is the same, though — the amount set aside is insufficient to cover the promises made.

You can expect to see more and more pension funds for folks like firefighters, cops, teachers and other governmental employees encountering the same trouble. Lower yields and higher life expectancies will render earlier endowment funding decisions inadequate. As a nation, we’re about to find out what the authorities will do to solve this problem but, as it stands, there is an enormous problem brewing before our very eyes.

The upshot of all of this is that you will increasingly be on your own. Your retirement (however that looks for you) will probably be longer than you anticipated, and whatever provision you had will probably be insufficient. Any provision promised you by others may well turn out to be for less, and for a shorter period, than you were counting on.

Forewarned is forearmed.

The solution

Invest more, starting today. Investing is a thing of patience and time. How long you invest has as much of an impact on your eventual fund than the return you get. Will it entail sacrifice? Almost certainly. But what’s the alternative?

Many people don’t want to learn how to invest. They think it’s too complicated, too risky or too time-consuming. So is eating. If you leave your investing to others, you are courting disaster. Some may have been lucky, but many ended up starring in American Greed or other horror tales of unsound, if not unscrupulous, investment middlemen.

It’s your future. Like it or not, there promises to be more of it. And that may make it worthwhile to become more involved in how you are going to fund it.

Not only do you bring up the important point of investing early on, but also, the benefits of entrepreneurship. You can’t control the government, but if you have your own company, you can control how funds are allocated and make sure your retirement isn’t being jeopardized for the sake of the bottom line.

Great article. I think in general there are three ways to best ensure a safe future: 1) have health insurance, and 2) learn to invest. I am constantly thinking about the future and although I acknowledge most of it is 100% out of my control I try to dwell on the parts that are: my retirement savings, investments, and personal relationships.

As to point 1, I am a man with what was once known as pre-existing condition, unfortunately disqualifying me from private health insurance completely. And realizing this old health care regime is finally over, you just made my day. My risk profile is profoundly improved now.

Before January 2014, the only thing I could do was 2. Learn to invest, and 3. Pray and hope I could keep working until the magical age of 65, known as Medicare.

I came to a realization around two years ago that the pension system here in Finland would not be there in 40 years when I am to retire (the official retiring age). So my plan for the future is quite simple, invest in dividend paying and growing stocks, buy and rent out a couple apartments and live well below our means. I’m taking a lot of steps towards self-sufficiency by growing my garden, foraging for wild edibles etc so that I can cut my food bill. Once we can afford we will buy a house with some land on it and I do believe that we can drastically reduce our fixed costs such as electricity, heat food etc by providing it for ourselves.
My grandparents are already living for 90+ years so unless something horrible happens I do believe that I will see 100 years, if I would retire at 65 there is no way I am going to put all my eggs in the same basket and trust that the state will provide for my income for 35+ years, starting in 40 years.

Part of the difficulty in making valuation decisions like the endowment calculation is that you don’t really want a fixed period endowment. The “actuarially correct” method is to come up with a probability that you will be alive in each payment period and then you need the discounted value of those payments at a risk free rate (practically 0 in today’s money, possibly even negative with inflation).

For most people, you should plan for the long tail lifespan and be satisfied if you die too early. If you want to use the fixed endownment (annuity) idea, assume a fixed annuity to live to 100 years old. Odds are good that even with decent mortality improvements, most of us won’t get there. At retirement, invest some portion in a true annuity product (it sucks to give away a profit margin to the insurance company, but you can consider it a method of insuring yourself against living too long. Long term care insurance is crucial too). That, combined with Long term care insurance, is your hedge against being alive forever. Then, you need enough to pay yourself on a slow runout until you are 95 or so, using very conservative investment values (think 0-2% return, tops). Reevaluate every 5-10 years, reaping a little reward or rebalancing your investment if you made too much interest on the market.

Well. If a person is in good health and enjoys what they do, why would they retire at 62, 65, 67, or any other arbitrary retirement age? I know a lot of folk that are actively working into their 80s and beyond.

You may not have a choice. If your company lays you off when you are 65, your chances of finding a job are quite slim. Unless you go into the “career” of being a Walmart greeter. Or what if you have a health issue that forces you to retire. Wanting to work until you are 80 is a great idea, and if you are able to do it then, great! But it is definitely a wise idea to be prepared just in case it doesn’t work out that way.

I’m 31 and my family seems to live into their early 90′s, so I do have to plan for quite a long time to cover after classic retirement…

We were actually saving a larger percentage of our income when we were making less. Self-employment has proven to be rewarding but less stable. We save more now, but it is around 10%-30% of our income instead of 40% like it used to be…

William, I think you meant “dike”, not “dyke”…
But quibbling aside – the answer is to do many things, not look for a single solution. If you can, work longer. If you can, continue your education to increase your earning potential. If you can, change jobs to get an increase in pay. If you can, buy an annuity. If you can, buy LTC insurance. If you can, save $1M. If you can, work in a job that results in a pension. If you can… do it all!

It’s risky to have a job – you feel safe with a steady income but the fact is you can lose that job any time. Investing actually spread the risc and can easily become a more secure income that a 9-5 job. And you can continue to do this even if you are in pension.

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